Investor must-read: How to develop stock selection strategies using Earnings Per Share (EPS)

The First Step to Understanding Company Value from EPS

Earnings per Share, abbreviated as EPS, is one of the most commonly used indicators to evaluate stock investment value. Simply put, it reflects the portion of net profit allocated to each outstanding share. Investors can quickly judge how much profit a company generates per dollar invested through this metric.

A higher EPS indicates stronger profitability efficiency. This is why many investors, when analyzing a listed company, first look at its EPS trend. From Apple (AAPL.US) 2019 to 2024 EPS data, it can be seen that as the company’s business develops, EPS continues to rise, signaling stable growth that investors favor.

Practical Stock Selection: How EPS Helps You Make Decisions

Many novice investors make the mistake of only looking at the absolute value of EPS. In reality, the true value of EPS lies in vertical and horizontal comparisons.

Vertical Comparison — Observing the Long-term Trend of a Company’s EPS

EPS data for a single quarter or year has limited significance. If a company’s EPS has been steadily increasing over the past five years, it indicates its profitability is strengthening and is a worthwhile investment target. Conversely, if EPS declines year over year or fluctuates wildly, caution is advised.

Horizontal Comparison — Comparing with Industry Competitors

Companies with higher EPS are generally more competitive within their industry. But there’s a key detail: the number of outstanding shares can change due to buybacks or issuance. To avoid being misled, investors should combine Price-to-Earnings Ratio (P/E ratio = stock price ÷ EPS) for assessment.

For example, in the semiconductor industry from 2018 to 2023, NVIDIA (NVDA.US), Qualcomm (QCOM.US), and AMD (AMD.US) showed different EPS performances. Although Qualcomm’s EPS was impressive after 2020, focusing only on EPS for stock selection would overlook NVIDIA’s 251% stock return during the same period, while Qualcomm’s was only 69%. This illustrates that EPS is just one of many factors in stock selection, not the whole truth.

P/E Ratio — Making EPS More Meaningful

When using EPS for stock selection, it’s essential to incorporate the P/E ratio as an intermediary indicator. Suppose Company A’s stock price is $30, and EPS is $1; then, the P/E ratio is 30. If the industry average P/E is only 10, it suggests the market is valuing Company A relatively high, possibly indicating overvaluation.

The P/E ratio also reflects market expectations for future growth. A high P/E may imply investors are optimistic about the company’s future earnings, while a low P/E could suggest market skepticism about its growth potential.

Accurate Calculation of EPS

Basic Formula

EPS = (Net Profit - Preferred Dividends) ÷ Number of Outstanding Common Shares

Where:

• Net Profit: Total revenue minus all expenses, at the bottom of the income statement
• Preferred Dividends: Dividends allocated to preferred shareholders, usually noted below the income statement
• Number of Outstanding Common Shares: Issued common shares minus treasury shares, reflected in shareholders’ equity on the balance sheet

Practical Example: Calculating EPS for U.S. Bank

Using U.S. Bank (BAC.US) 2022 financial report:

1. Find net profit of $27.528 billion and preferred dividends of $1.513 billion from the income statement.

2. Check the weighted average number of common shares outstanding: 8.1137 billion shares.

3. Calculate: EPS = ($27.528 billion - $1.513 billion) ÷ 8.1137 billion = $3.21

Financial reports usually directly list “Net income attributable to common shareholders” divided by the number of shares, yielding the same result. Most investors do not need to calculate this manually, as listed company reports disclose EPS directly.

Methods and Channels to Check EPS

Official Financial Reports (Most Accurate)

For example, to check Apple (AAPL.US):

1. Visit the U.S. Securities and Exchange Commission (SEC) website, sec.gov, and access “SEARCH EDGAR”.

2. Enter search criteria: for quarterly reports, input “10-Q”; for annual reports, input “10-K”; company code: “AAPL”.

3. Open the relevant report, locate the “CONSOLIDATED STATEMENTS OF OPERATIONS,” and find the “Earnings per share” item.

Financial Data Websites (Convenient but May Be Slightly Delayed)

Websites like SeekingAlpha, Yahoo Finance offer free EPS data, but be aware of different EPS types—basic EPS, diluted EPS, forecast EPS, etc. Generally, it’s recommended to analyze Basic EPS.

Traps Behind EPS: Important Details You Must Know

Impact of Stock Buybacks

Continuous large-scale buybacks reduce the number of outstanding shares. With the same profit, a smaller denominator artificially inflates EPS. Investors unaware of this may mistakenly think profitability is improving.

Distortion from Special Items

If a company sells assets, divests a business line, or receives tax subsidies, these one-time gains are included in net profit, artificially boosting EPS. For example, if a restaurant chain sells real estate for a large sum, this income should not be included in regular operating EPS for valuation.

Investors need to distinguish between ongoing operating EPS and adjusted EPS, with the latter better reflecting the company’s true operational ability.

Difference Between Diluted EPS and Basic EPS

Financial reports typically list two EPS figures:

Basic EPS

Reflects current facts, calculated as: Basic EPS = (Net Profit - Preferred Dividends) ÷ Number of Outstanding Common Shares

Diluted EPS

Considers potential dilution risks, calculated as: Diluted EPS = (Net Profit - Preferred Dividends) ÷ (Outstanding Common Shares + Convertible Dilutive Securities)

Convertible dilutive securities include stock options, restricted stock, warrants, and convertible bonds. For example, Coca-Cola (KO.US) in fiscal year 2022 had net income of $9.542 billion, 4.328 billion shares outstanding, and 22 million convertible securities. Then: Diluted EPS = $9.542 billion ÷ (4.328 billion + 0.022 billion) = $2.19

Comparison

Diluted EPS helps investors evaluate how fully diluted ownership might be affected.

The Relationship Between EPS, Stock Price, and Dividends

EPS and Stock Price

Generally, EPS and stock price are positively correlated—strong EPS boosts investor confidence and drives up stock prices; the opposite is also true. However, this relationship is not absolute. If a company’s EPS falls short of market expectations, even with growth compared to previous periods, the stock may be sold off; conversely, if EPS exceeds expectations, stock prices may rise even if EPS declines sequentially.

EPS and Dividends Per Share (DPS)

DPS is the dividend paid per share, calculated as: DPS = Total Dividends ÷ Number of Outstanding Shares

EPS measures the company’s net profit generated, while DPS indicates the portion returned to shareholders. A high dividend yield suggests most profits are distributed, leaving less for reinvestment, which may limit future growth. Conversely, growth companies often retain earnings for expansion.

Frequently Asked Questions

Q: How much EPS is considered good?

A: There is no absolute standard. The key is to observe the trend—continuous growth indicates increasing profitability; compared to industry peers, higher EPS suggests stronger competitiveness. It’s more important to analyze multiple metrics like P/E ratio, growth rate, rather than focusing solely on a single number.

Q: Can EPS be predicted?

A: Yes. Wall Street analysts forecast future EPS based on company outlooks. Investors can judge whether market expectations are reasonable by comparing forecasted EPS with actual reported EPS.

Q: How to avoid being misled by EPS data?

A: Deeply analyze the underlying reasons—distinguish whether special items, stock buybacks, or changes in outstanding shares influence EPS. Also, compare with industry peers and consider multiple financial indicators for comprehensive judgment.